Topic – Venture Capital Advantages and Disadvantages | LATEST UPDATED
Do you know that the success rate of Venture Capital is only 1 in 2000? The rapidly transforming economic environment signifies tremendous scope for venture capital. However, the need to establish a sound venture capital movement is equally humongous.
As it is rightly said,
“Every coin has two sides.”, Venture Capital has both advantages and disadvantages.
Before we dive deeper, let us try and understand what exactly is venture capital. Venture Capital or ‘financing of innovation’ identifies and funding early-stage startups expecting a high return on investment.
The aim of a venture capitalist is to finance young businesses in order to grow them into commercially successful large businesses. Some of the well-known companies of the world, like, Apple Computer, Cisco Systems, eBay, etc. are venture-backed startups.
Venture Capital advantages and disadvantages, like any other startup funding choices, should be weighed before funding. In exchange for equity, venture capitalists provide funds to fast-growing businesses.
It eliminates debt payments and offers founders much-needed guidance. There are pros and cons of venture capital. Let us have a look at Venture Capital Advantages and Disadvantages.
10 Advantages of Venture Capital
Following are the top10 advantages of VC –
- A big amount of Funds can be raised
- Risk management help is provided
- No Regular Payments Are Needed
- Personal Assets Are Safe
- Guidance From Experienced Leaders Is Available
- Networking Opportunities Are Available
- Collaboration Opportunities Are Available
- Hiring Assistance Is Available
- The Likelihood of Exposure And Publicity Increases
- Subsequent Funding Assitance Is Available
10 Advantages of Venture Capital In Detail –
1-Huge Amount Of Capital Can Be Raised
Many startup loans are limited to $5 million, and qualifying for one might be challenging. Venture funding, on the other hand, can range from $100,000 for a seed-stage business to more than $25 million for established startups in the market.
Startups also have a need to raise venture capital multiple times. It allows them to access significant sums of money.
2-Risk Management Help Is Provided
Bringing on venture funding helps startup owners manage the risk that comes with starting a business. Startups are more likely to avoid severe challenges if they have an experienced team overseeing their growth and operations. Although the failure rate for businesses remains at 20% in the first year, having someone to turn to for help when faced with a difficult scenario can increase the chances of making the right decision.
3-No Regular Payments Are Needed
A venture capital firm will invest in your company in exchange for equity in the company. This implies that, unlike small businesses and personal loans, your company will not be required to make monthly payments.
This frees up capital for your organization, allowing you to reinvest instead of clearing interest by upgrading products, hiring more people, or expanding operations.
4-Personal Assets Are Safe
In the vast majority of circumstances, you will not be required to contribute personal assets to the expansion of your company. While many startup funding options require founders to put their houses or other personal assets up as collateral to cover beginning expenditures, most venture capital agreements exclude the founder’s personal assets.
5-Guidance From Experienced Leaders Is Available
After exiting their company, many successful startup founders become partners at venture capital firms. They frequently have prior expertise scaling a business, resolving day-to-day and broader difficulties, and tracking financial results.
They are generally experienced at assisting startups and sit on the boards of as many as ten at a time, even if they do not have a startup background. As a result, they can be important leadership resources for the businesses in which they invest.
6-Networking Opportunities Are Available
When you’re focused on your business, you don’t always have time to network with people who can assist you in growing it. A venture capital firm’s partners can spend up to half of their time establishing their network to help the startups they invest in.
This network can assist you in forming new collaborations, expanding your client base, hiring key staff, and raising future rounds of finance.
7-Collaboration Opportunities Are Available
When you acquire venture capital funding, what you are getting is “smart money”. This implies that the money you receive comes with the added benefit of the venture capital firm’s expertise. To get your company on the proper track to growth and success, you’ll frequently collaborate with firm partners, other startup owners who have received capital, and specialists from both of their networks.
8-Hiring Assistance Is Available
The team you need to launch a business and the team you need to scale it are not the same, and venture capital firms can help you hire crucial people to help you scale. Furthermore, many potential employees may view a venture-backed firm as less risky than a traditional startup with no capital, making it easier to hire a strong and diverse workforce.
9-The Likelihood of Exposure And Publicity Increases
Most VC companies have a public relations team and media contacts, and it is in their best interests to get your startup noticed.
Being affiliated with a company can give it a lot of credibilities, especially for entrepreneurs who haven’t developed any other successful businesses. Increased visibility may attract the attention of potential workers, customers, partners, and other venture capital companies looking to raise funds.
10-Subsequent Funding Assitance Is Available
Venture capital investors want to see your company raise additional financing at a better valuation. They may be able to connect you with other venture capital firms that can help you at a later stage and provide further cash.
VC firms frequently reserve the right to invest in subsequent rounds of fundraising and frequently contribute extra funds as the startup expands.
Continue Reading for Venture Capital Advantages and Disadvantages.
10 Disadvantages of Venture Capital
Following are the top 10 Disadvantages of VC –
- Founder Ownership Is Reduced
- Finding Investors Is Distracting
- Funding Is Often Difficult To Obtain
- Cost Of Financing Is Expensive
- Formal Hierarchical Structure Is Needed
- Due Diligence Is Needed
- Business Is Expected To Grow Rapidly
- Funds Are Provided On Performance Basis
- Possibility To Lose The Business Exists
- Leverage For Startups Is Rare
Disadvantages of Venture Capital In Detail –
1-Founder Ownership Is Reduced
There occurs a need to dilute your equity so as to issue new shares to investors when raising a funding round. Many businesses outgrow their original funding and require further rounds of funding from venture capital firms.
Founders lose majority ownership of their company, as well as the control and decision-making power that comes with being a majority shareholder, as a result of this process. Founders can reduce this risk by just raising the funds they require.
2-Finding Investors Is Distracting
When original funds have been exhausted but funds are required for expansion, startups realize it’s time to raise venture capital. However, fundraising might take months and should not be done at the expense of running the business.
Founders give themselves enough time to both, continue to expand the firm and collect sufficient funds to keep growing by commencing the process before the need is realized.
3-Funding Is Often Difficult To Obtain
Only around 5,000 venture capital deals were made in the United States in 2018, as per a report by the National Venture Capital Association. Almost 3,000 of these businesses have previously received venture capital funding. According to venture capitalists, for every three startups they invest in, they receive as many as 1,000 proposals.
An incubator or accelerator can be one option for entrepreneurs looking for their first round of funding. They frequently provide up to $150,000 in the capital as well as a three-month boot camp to prepare businesses for growth and future rounds of funding.
Angel financing is another option for startups looking for smaller sums of money with flexible terms.
4-Cost Of Financing Is Expensive
When compared against taking out a loan, giving up equity in your firm may seem to be a bargain. The cost of equity is only realized when the company is sold. Venture capitalists offer much more than just funds. They provide guidance and eminent leadership. Perhaps this is not a casual decision especially if there are other financial options.
Two startups, for example, each require $1 million and are valued at $10 million. The first business takes out a 10-year SBA loan for startups at 10% interest, while the second raises $1 million for 10% ownership.
If both companies sell for $100 million in ten years, the first company’s founders will have paid $600,000 in interest and maintained ownership, while the second company will have lost $10 million in proceeds from the sale owing to equity dilution.
5-Formal Hierarchical Structure Is Needed
You’ll be compelled to establish a board of directors and a more rigorous organizational structure provided you receive venture capital. Both enhance the company’s growth and transparency thereby allowing it to scale. This can limit the company’s flexibility and limit the amount of power the founders have. It is, nonetheless, advantageous to a fast-growing corporation.
This structure is imposed purposely by venture capital firms to oversee the company and diagnose any difficulties. Problems arise frequently as a result of faster expansion, and they must be addressed on an urgent basis before they spiral out of control.
These higher levels of reporting and openness provide confidence to venture capitalists.
6-Due Diligence Is Needed
Because the capital invested comes from outside contributors, venture capital partners must extensively screen firms. There are two stages to this. The first stage involves evaluating your technology and business fundamentals to see whether there is a market and if the firm can be scaled.
They perform a more extensive evaluation of your team’s background, as well as the startup’s financial and legal condition, in the second stage.
Despite the fact that this procedure is time taking it is helpful if the companies go through it. It is easier to repair problems when they are identified early. Because many flaws have already been assessed and resolved, future rounds of fundraising will be easier as well.
7-Business Is Expected To Grow Rapidly
Venture capital firms need your startup to appreciate in value on its route to being purchased or listed on a public stock exchange in order to obtain a return on their investment. This certainly adds to the already high pressure that entrepreneurs are under. There are, however, solutions for entrepreneurs to cope with their anxiety.
Founders may ensure that their goals are aligned with that of investors. Founders should reduce their workload by delegating as and when necessary. This shall allow founders to focus their energy on important aspects of the company.
8-Funds Are Provided On Performance Basis
Venture capital funds are released in stages as the startup achieves specified milestones. These are business-specific, but they include revenue targets, customer acquisition goals, and other criteria set by the venture capital firm. These objectives, as well as any conflicts, should be discussed with the board.
If the aims are the only thing on the founders’ minds, it might be distracting, but it also leads to higher economic success.
9-Possibility To Lose The Business Exists
Underperforming founders risk losing their companies. Founders are frequently let go if Agency Problem exists or if they do not optimize shareholder value. To reduce this risk, founders should obey their board of directors and talk about their strategies and objectives.
10-Leverage For Startups Is Rare
Most entrepreneurs seek venture capital only if it is the only way to meet their financial needs. When there are too many investors interested, the startup has negotiating power over the conditions. However, this condition is rare. Most often, other than rejecting the purchase, most companies will have little leverage.
This can be avoided by beginning your search for a venture capital firm that knows your aims and funding requirements as early as possible.
Types of Venture Capital
We read about the Venture Capital Advantages and Disadvantages. Now let’s see the types of VC. Venture Capital is classified according to how the funds are used at different stages of a company’s life cycle. There are 3 main types of Venture Capital.
They are Early Stage Financing, Expansion Financing, and Acquisition/Buyout Financing.
Early Stage Financing can be Seed Financing, Startup Financing, or First Stage Financing. Seed finance is a small sum of money lent to an entrepreneur so as to make the startup eligible for a start-up loan. Companies are provided start-up funding in order to complete the creation of products and services.
Companies that have spent all of their initial money and require financing to launch full-scale commercial operations are the primary beneficiaries of First Stage Financing.
Second-stage Financing, Bridge Financing, and Third-stage Financing, often known as Mezzanine Financing, are types of Expansion Funding. Second-stage finance is given to businesses to help them get started on their expansion plans. It is offered with the intention of supporting a specific company is expanding significantly.
Companies that use Initial Public Offerings as the main business strategy may be eligible for bridge financing as a kind of monetary support.
Acquisition Finance and Management or Leveraged Buyout Financing are two types of Acquisition/Buyout Financing. Acquisition financing enables a corporation to purchase specific components or the complete company. MBA/LBO allows a group of executives to acquire a specific product from another company.
Why is Venture Capital so Expensive?
The risk involved in investing in a startup makes Venture Capital expensive. Also, venture capitalists look for healthy and promising firms. What enhances the expense of Venture Capital is engaging with sub-prime venture capitalists who do not understand that the trajectory cannot be bumpless.
Who Venture Capital is Right for?
1-Founders With No Prior Experience Scaling A Business
Venture capital partners have scaled dozens of businesses, making them a valuable source of information and expertise. In addition to the funding, scaling can be another benefit.
2-Startups Experiencing Rapid Growth And Need To Scale
Getting venture capital funding can help you expand operations if your firm is currently developing at a fast pace. The number of pain points can be lowered to keep up with the demand. Meanwhile, still maintaining or enhancing the quality of your offerings.
3-Founders Requiring Many Multimillion
Dollar investment rounds: One of the few sources of finance that can provide several million dollars over several years is venture capital. Some firms require a lot of money, especially if they want to keep acquiring consumers even if they aren’t profitable yet.
4-Startups In Fast Developing Undeveloped Markets
In a growing industry, startups frequently find themselves as one of the few rivals. Traditional bankers are unlikely to lend to such businesses venture capital firms would. This money can help startups grow and try to capture a substantial portion of a growing market.
5-Founders Needing Industry Knowledge And Connections
The right venture capital firm can make a tremendous difference considering you do not have the relevant experience. The chances of failure can be lowered by leveraging their experience and contacts.
Concluding Venture Capital Advantages and Disadvantages
Startups with tremendous growth potential in fast-growing industries are strong candidates for venture funding. They can provide big sums of money over a long period of time, as well as expertise in scaling.
However, not every firm is scalable right away, and until they are, founders might seek investment from sources other than venture capital.
This concludes the topic of Venture Capital Advantages and Disadvantages 2021-2022.
Hailing from the holy city of Varanasi, Shivansh, a travel junkie, is an MBA in Finance from the Indian Institute of Management. He owns a light-hearted YouTube channel called ‘Life of an IIMite’ and also has an English Grammar course running on Udemy. A foodie and a fitness freak at the same time, Shivansh has been passionate about writing since his teens & took up freelancing soon after. Let’s Connect,